Digital disruption and the old firms

With the old way of doing business being increasingly disrupted by technology and new business models, what will happen to the established firms that grew big in the 20th century?

AT the recent Innovation Awards & Summit 2015 by The Economist in Hong Kong, I represented Malaysia and engaged in a lively debate with Steve Monaghan, AIA’s regional director.

I was tasked with arguing against the motion on whether Asia’s established firms — the “old guards” — could survive the era of digital disruption and out-innovate the younger startups. The following are excerpts from the debate:

Most of the big firms that have been around for decades in Asia are family businesses or conglomerates. They are generally companies of more than 20 years, such as the state-owned-enterprises in China, the keiretsu in Japan and the chaebol in Korea. They’re sometimes referred to as “dinosaurs.”

As the term “innovation” has been overused in many ways, for the purposes of this debate, let me offer my definition so that we are all on the same page: Innovation is about creating new solutions to new problems, and is meant to disrupt existing industries and business models.

Although big firms in Asia have done well in the past (for example, Toyota invented lean manufacturing and Samsung’s mobile devices have dominated the Android market), the argument today is whether these old Asian firms are innovative enough compared to 1) its western counterparts and 2) startups around the world (Tencent, Alibaba, Uber, Facebook, etc), and I would argue that they’re not.

Samsung is constantly fighting for market share with Apple, and mostly copying their innovations, and now is increasingly challenged by Xiaomi, a relatively young upstart. Nintendo struggled to transition into next generation consoles and mobile gaming, and are now eclipsed by companies such as GREE and Gungho.

These incumbents have struggled to move quickly and would have to adapt or die. I believe most will die.

When 90% of the Dow Jones Industrial Average constituents have changed over the past 50 years, it’s obvious that innovation happens when small fish eats big fish.

I frame my arguments based on three points: ROI, DNA and data.

ROI: Most established firms are public and measured on short-term quarterly financials. This makes it tough for corporates to move fast enough against their challengers as they risk cannibalising their core business. They also have to fight internal politics for resources and mindshare.

Even if they did invest and eventually acquire some startups, the heavy dinosaur culture will end up killing the startup once inside. Big companies are run by salarymen and women. Bureaucracy, risk aversion and current compensation structures simply doesn’t financially incentivise big companies to innovate.

DNA or tradition: Asia especially is a land never conquered by institutional shareholders. About 67% of Asia’s biggest conglomerates are state- or family-run. Unfortunately, today, 65 of Asia’s state-owned firms have lost a trillion dollars in value since 2007.

Their downfall is attributed to: dependency on state lending policies, lack of accountability to outside investors, and not being nimble enough to cope with dynamic markets. In fact, this risk is highest in banking and telcos. Japan’s mobile phone operator, NTT DoCoMo, has struggled to keep up.

In China, Alibaba, Tencent and Xiaomi have all secured banking licences to take on the country’s four state-owned banks. As firms mature and compete in global markets, the Asian conglomerate model of protectionism has to be reformed.

Data: While most big companies have a large user base and copious amounts of data, data has never been central to the old guard’s strategy and culture in making product or marketing decisions.

In smaller more agile startups, data is constantly used to run experiments and validate new ideas. This results in better data-driven decisions. The Ubers, WeChats and Facebooks of today are valued as data companies to justify the premiums in valuation. Big companies will not be able to catch up to this.

By definition, innovation requires new thinking. It’s very difficult for an incumbent to seed innovation from within. In fact, it’s almost impossible. Even if corporate incubators are successful, these so-called innovations are still bolted to the core businesses.

Any big company R&D spend goes to incremental improvements: how to make existing products cheaper, faster, better. Startups will completely disrupt existing business models and make current competition irrelevant.

For established companies in Asia to survive, they have to firstly de-establish themselves, forcing a complete reinvention. Therefore, Asia’s established firms will NOT survive in its current shape and form. Even Google boldly restructured itself into Alphabet. It’s no longer just a search company, but a company with moonshot projects.

This move was crucial for Google’s own survival over the next 50 years. A startup’s biggest advantage is its agility.

As John Rice, vice chairman at General Electric (GE) and panelist at The Economist Summit, puts it: “We have to be an agile dinosaur... We have to go through a process to really rethink how we want the company to be in the 21st century. We cannot remain attached to the factors that contributed to our success in the 20th century. We have to change.”

When 900 executives were asked when disruption is expected to impact their industry, the average time was 3.1 years. Incumbents now face the “innovator’s dilemma.”

“Premature abandonment of the core” is the agony of most market leaders. Business models that make them good now actually make them bad at disruption. Most still have considerable value they can and should extract from digitising operations, so they play defensive.

But traditional profit pools are leaking. Competitive dynamics — such as unpredictability, rapid acceleration, recombination of the value chain — place a premium on foresight, experimentation, and fast execution. Economic conditions such as free trade and global e-commerce; New social trends; how social networks have become our primary communication mode, have fundamentally changed the way we work.

New technologies like self-driving cars, NEST, and drones are emerging from new firms who can attract the best talent, not dinosaurs. “Economic rent” is now flowing from incumbents to challengers, from traditional cable to Netflix, from taxi’s to Uber, from hotels to Airbnb.

As society moves up Maslow’s hierarchy of needs, old Asian firms who achieved riches from providing basic infrastructure are no longer relevant. While boardrooms can identify the need to change, it’s rarely translated into action. New global firms who can appeal to the “self-actualisation needs” of the rising middle income class, will prevail.

If big established firms are dinosaurs, startups are like leopards who CAN change its spots quickly. Many of Asia’s dinosaurs do not have the courage and foresight to embark on such radical transformations.

To conclude, it was unanimously agreed that change is most important for innovation. Ong Chih Ching, chairman and executive director at the Singapore-based KOP Limited shared: “The biggest enemy is change. But if you want to be innovative, to a certain extent you have to change.”